JPRI Working Paper No. 63: December 1999
Saying No to "Socialism:" The New Politics of the Income Tax in Japan
by Andrew DeWit
"The less people know about how sausages and laws are made, the better they'll sleep at night." - Otto Von Bismarck
While insisting, before a House of Councillors Budget Committee on February 23, 1999, that he has "long regarded the Japanese income tax as akin to that of a socialist country," Finance Minister Kiichi Miyazawa recently helped slash Japan's top personal and corporate income-tax rates to their lowest levels in the postwar era. His comment seemed particularly odd since he and his fellow Liberal Democrats presided over the tax system's construction, and until recently at least, most observers saw it as rather soft on capitalists. But it turns out that Miyazawa was employing the term "socialist" politically rather than analytically, the object being to bash redistribution and thus legitimate regressive tax reforms. He, and a growing chorus of like-minded critics, is clearly betting that in tax politics, as in selling cat food, if something is said often enough a lot of people will eventually buy it.
Tax policymaking in Japan thus looks depressingly Anglo-American in that it is driven more by ideological claims than reasoned arguments about balancing equity and economic incentives. In spite of the flood of specious statements in Japan's tax debate, however, many features of the tax system itself are more or less amenable to objective assessment. This is especially true if one focuses on comparisons with other cases. I shall take this approach in challenging the myth of highly redistributive income taxation in Japan by taking a brief, comparative look at Japan's personal income tax prior to the reforms enacted in 1999. I shall then discuss these reforms and their political background, followed by some comments on where Japan's tax system appears to be headed, why, and to what probable effect.
Comparing Japan's Income Taxes
Mark Twain could have been leafing through a proposal for tax reform when he declared that "facts are stubborn, but statistics are more pliable." Even so, statistics can provide a handy check on the tendency to make sweeping generalizations about the Japanese fiscal system. Table 1, for example, gives little evidence that Japan is a highly redistributive state. As of this writing, the most comprehensive comparative revenue statistics available are from 1996. Japan's tax bite as a share of GDP was, as most of us would expect, close to that of the United States but far lower than in the other advanced industrial democracies. This point remains true even after taking into account the fact that Japan's revenues were depressed by its flat economic performance in 1996.
Table 1: General Government Revenue 1996, Percent of GDP
Source: Organization for Economic Cooperation and Development (OECD), Revenue Statistics, 1965-97
But how about what is taxed? Neoliberal reformers often insist that income taxes are too prominent in Japan's tax mix, implying an enormous, leaky bucket of redistribution and lost incentives. To check whether the overall character of Japan's tax system is unusual, Table 2 compares its take from income and profits. This table shows that while Japan's reliance on these taxes--in proportional rather than absolute terms--is high compared to France and Germany, it is roughly equal to that of the United Kingdom and considerably lower than the United States. Again, Japanese figures are depressed somewhat due to the effect of temporary tax cuts and slow growth during 1996. But with the exception of 1990, the peak year of the bubble economy, Japan's taxation of income and profits has been consistently well below that of the U.S.
Table 2: Taxes on Income and Profits in 1996 as Percent of Total Taxation
Source: OECD, Revenue Statistics, 1965-97
A more broadly comparative picture of these countries' tax systems is given in Tables 3 and 4 at the end of this paper, which measure the relative reliance on the main tax fields of income, assets and expenditures as a percentage of 1) total taxation and 2) gross domestic product. Japan displays a strong touch of modern Anglo-America fiscal culture in drawing much of its revenues from income, profits, and property but little from goods and services (the United Kingdom's high burden on consumption, through its VAT, is a legacy of Thatcherism and EU membership). On the other hand, Japan looks more European through its heavy reliance on social security contributions in its tax mix.1
The Personal Income Tax
Beyond showing that Japanese taxes do not appear especially onerous or redistributive in the aggregate, general statistics are of limited usefulness because they obscure important differences in particular fiscal instruments. For example, the structure of the personal income tax varies greatly from country to country, with two of the most obvious and important differences being the level of exemptions and the tax rates.
Sophisticated reformers, like Miyazawa, argue that Japan's minimum exemption for personal income is so unduly high that it hollows out the tax base and unfairly shifts the tab to the upper-income salaryman. The exemption specifies the level of earnings sheltered from the income tax, i.e., anyone earning below the stated level is exempt from tax, and even those earning more can deduct the minimum from their gross income in order to arrive at their taxable income. Table 5 compares several countries' exemptions in 1999 for a salaried worker with a spouse and two children. While Japan's level is high in comparison with Britain's, and to a lesser extent America's, it is in fact lower than what we find in France and Germany. Certainly Japan's exemption can hardly be described as so extreme that it "was unknown even in the former Communist countries," as Heizo Takenaka, a Keio University public finance economist describes it.2 He made this claim using Japan's 1998 exemption for a family with two children--namely, ¥4,910,000--which is indeed very high but reflected a temporary tax cut.
Table 5: Personal Income Tax Minimum Income Exemption, 1999 (Units: Ten Thousand Yen)
Source: Ministry of Finance, Japan. The exemption is calculated for a salaried worker with a spouse and two children in FY 1999.
Table 6 shows that this point is even more true when we compare the minimum exemption that applies to a single worker in 1999. Here we see that Japan is much closer to the Anglo-American countries than it is to the Europeans.
Table 6: Minimum Income Exemption for a Single Worker, 1999 (Units: Ten Thousand Yen)
Source: Ministry of Finance, Japan
What have, in fact, been high are Japan's personal income tax rates. Throughout most of the 1990s, up to the 1999 reforms, the national levy ran from 10 to 50 percent, in five brackets, with a 3-bracket local income tax imposed on the same base at rates of between 5 to 15 percent. In theory, therefore, a high-income taxpayer would find himself paying a 65 percent rate of tax on the increment of income in excess of 30 million yen.
But recall the earlier tables that showed Japan's taxation of income and profits is moderate. This suggests that the relationship between tax rates and effective tax burdens is more complicated than many pundits would have us believe. The tax burden depends not only on the rates and on how much income is exempted--for example, via the basic personal exemption--but also on how different kinds of income are taxed.
Consider, for example, the British income tax. The United Kingdom has a fairly simple structure that includes only 3 brackets and a top rate of 40 percent (with no local income tax). Even with this comparatively modest income tax, the state managed to collect 9.3 percent of GDP in 1996. As Table 7 reveals, this is considerably more than the Japanese level of 5.7 percent in the same year. The difference is mostly due to Britain's low basic exemption, which means that a lot of the working-poor pay income tax, as well as the fact that the top rate kicks in at 1.8 times the average production worker's annual income. By contrast, Japan's top rate does not apply until 7 times the average production worker's annual income.
Table 7: Personal Income Taxes in 1996, as Percent of GDP
Source: OECD, Revenue Statistics, 1965-97
However, these are not the only reasons for the big difference in revenue yield. The French system, with its six brackets, has a top rate of 54 percent. As in the United Kingdom, there is no local income tax, and the top rate applies at just over twice the average production worker's annual income. Yet although France's top income tax rate is 14 points higher than the British one, it is applied to a much narrower base. As we saw in Tables 5 and 6, the French basic exemption greatly exceeds the British one and is even more generous than the Japanese. This is clearly one reason the French collected only 6.4 percent of their GDP with the income tax in 1996, as seen in Table 7.3
Apart from legal exemptions and deductions, another reason for the low productivity of the French income tax is tax evasion, something for which French taxpayers are notorious. Japan's small businessmen and farmers are no slouches in this regard, either, and are often said to evade income taxes by hiding, respectively, 40 and 60 percent of their gross incomes. Adding to the inequity, upper-income earners who would appear to fall into the higher tax brackets in fact pay sharply lower rates of tax on income they receive in the form of interest, dividends and the like. As Richard Katz points out, "Interest is tax-free on deposits up to ¥3 million ($25,000), and tax evasion through multiple accounts is widespread. In fact, half of all deposits are in tax-free accounts. Beyond that, interest earned in Japan is taxed at 20 percent."4
Whether Japan's personal income tax should redistribute income to a greater or lesser extent than it does at present is, of course, a political rather than empirical question. But from a comparative perspective, it is clearly excessive to depict is as socialist. Indeed, as Hiromitsu Ishi concluded in his own extensive study of the system, "In terms of effective, not statutory tax rates, the income tax system in Japan is only mildly progressive and therefore has little effect on the relative distribution of income."5 Moreover, he made this assessment before the bulk of the tax reforms of the 1990s.
So Much For Socialism: The 1999 Reform
Japan's most recent income-tax cuts took effect in fiscal 1999 and center in particular on boosting economic growth and enhancing the incentives for high-income earners and corporations to produce. The LDP and its coalition partners, concerned at the cuts' blatant inequity, made adjustments to the minimum and dependent exemptions. Had they not, middle and low-income families would have faced a stark tax increase due to this year's simultaneous expiration of an earlier one-time-only tax reduction. However, the current reform's most significant aspects are that the LDP slashed the top national income tax rate from 50 percent to 37 percent (thus bringing it below the Americans' 39.6 percent top federal rate). Also, the standard corporate income tax rate has been cut from 34.5 to 30 percent, the small business rate from 25 to 22 percent, and the municipal business tax applied to both large and small firms was trimmed from 11 to 9.6 percent. The effective corporate tax rate on large firms has thereby dropped rather precipitously from 46.36 percent to 40.87 percent, and this is after being cut from 49.98 percent the previous year. In fact, Japan's personal and corporate income-tax rates per se are now lower than they have been during the entire postwar period.6
All told, the most recent reform slashed 9 trillion yen from Japan's income-tax revenues. The 1999 budget, which also included another huge dollop of public works spending, zipped through the legislative process in record time, its regressive aspects causing little public debate. The quiet was no doubt in large part because almost all major interest and income groups received a tax cut (or at least a construction contract) and no one talked about how to pay for the free-for-all. This latter aspect, however, has perturbed many in the public finance community.7
Among the main forces propelling Japan's tax reform were concerted corporate lobbying and the pressure of events, which bulldozed it past all qualms. Keidanren, Keizai Doyukai, and other business interest groups have gained great policymaking influence over the course of the Heisei recession. They have consistently demanded drastic reforms to Japan's personal and corporate income-tax regimes, but they kept running into obstructionism from the Ministry of Finance and its insistence on fiscal austerity. Then, in 1997, the Hashimoto regime hiked the consumption tax and health-care premiums, which helped drive the economy into a full-blown recession. Political calculations underwent a massive shift, which was hastened when the LDP lost heavily in the July 18, 1998 Upper House elections. Hashimoto soon found himself out of a job, bureaucrats were shoved to the tax policymaking sidelines, and a hodgepodge of supply-side and consumption-oriented tax cuts started being thrown together.
The momentum toward a large, permanent income-tax cut accelerated with the transition to Obuchi and his sensitivity to foreign and domestic demands for decisive action. Choices became falsely polarized between either an irresponsible retreat into renewed fiscal austerity or an all-out, deliberately extravagant tax cut. As a result, a neoliberal's wish-list of tax reforms became the basis of the 1999 budget package, announced in mid-December of 1998. Word has it in public finance circles that some officials in Keidanren, having gotten virtually all they had asked for, were taken aback by this outcome and ironically have started to voice their concern for the health of the fiscal system.
For individuals, the personal income tax cuts include the following effects. A single taxpayer earning ¥2 million (about $18,200 at US$1=¥110) in 1999 will see his tax burden decline by ¥19,625 (US$178) to ¥87,875, whereas the cut in the top rate will give a single taxpayer earning ¥50 million a rather more generous reduction of ¥3,356,500 (US$30,514), leaving his total tax burden at ¥19,401,500 (US$176,380). Moreover, this tax reduction for upper-income individuals comes on the heels of earlier cuts. As a result of successive tax reforms, a taxpayer who pulls in ¥50 million in ordinary income now pays a whopping ¥9.18 million (US$83,455) less per year than he would have in 1987.
Table Eight at the end of this paper presents comparative data showing the 1999 reforms' consequences for a married taxpayer with two children, at various income levels. This table also indicates whether, as Miyazawa and others suggest, the current income tax remains too redistributive even after the recent reforms. The table shows that Japan still looks much like France, the epitome of light income taxation, in imposing low burdens up and down the income scale. As one would expect from the data presented in previous tables, it is the Germans who stand out for their minimal imposition on families with the lowest incomes and their redistributive bent.
Paying the Tab
Japan's recent tax cuts will reduce the recession-bound system's revenues to only about ¥47 trillion in fiscal 1999. This will return it to levels not seen since the early 1980s and will also require deficit financing to the tune of about 10 percent of GDP. The deficit will raise Japan's aggregate debt to well over 100 percent of GDP, posing serious challenges for a fiscal system already facing mounting burdens from an ageing population and economic adjustment. Nor are these costs, although immense, the only ones. Because the progressivity of the income tax system has been so curtailed, Japan cannot expect large natural increases in revenues from it even if economic growth eventually resumes beyond what is forecast in the currently bleak scenarios. Yet it seems politically and economically unlikely that large-scale deficit spending can continue forever, which means that at some point there will have to be major cuts in spending or massive increases in taxes, or some combination of the two.
There is, of course, no shortage of people who argue that there is ample room for spending cuts in Japan. Some claim that fully one quarter of government personnel could be trimmed, but this seems largely rhetoric and wishful thinking. Admittedly, modern Japanese history shows that the state has an enormous capacity to organize austerity and shift much of the cost of socioeconomic change onto households. But as comparative work repeatedly demonstrates, Japan already has the industrialized world's lowest ratio of public servants to population. Moreover, demographic trends would suggest that expenditures for personnel and services are, if anything, likely to increase. Added to this, the country is gradually moving away from price guarantees and other off-budget means--such as the Fiscal Investment and Loan Plan--of providing a social safety net and social infrastructures. This means the burdens on the fiscal system may very well increase beyond what we can project simply as a result of the ageing population.
As for tax increases at the upper-end of the income scale, these are always possible but the political environment looks forbidding. Going back on the recent reforms looks like a non-starter, since income tax rates are very hard to raise once they have been cut. Moreover, the forces that would oppose such a move are now well-represented in policymaking circles. They combine organizational strength, lots of money, and an inexhaustible supply of arguments "proving" that fiscal equity must go in order to cope with globalization, foster entrepreneurialism, and--unbelievable as it may seem--enhance Japan's incentives to work. They can thus be counted on to insist that Japan has achieved a degree of equality that negates any need for redistribution, a claim that ignores the evidence that inequality in Japan has increased in the last decade to where it is well in excess of European levels and not that far behind the United States.
It therefore seems a safe prediction that Japanese fiscal authorities will draw a large share of their future revenue needs from increases in the consumption tax and cuts in the minimum income exemption. Such reforms are themselves politically difficult because of their regressiveness, but they can be done incrementally in order to reduce the potential for backlash. Miyazawa in fact favors cuts in the minimum income exemption, both because of the consumption tax's surprisingly adverse effect on the economy and a bizarre claim--the exact opposite of a Reaganite tax reform tenet in 1986--that it is undemocratic for large numbers of lower-income citizens not to pay income taxes.8
Either of these approaches would shift much of the tax burden onto the shoulders of middle- and lower-income Japanese. Whether that is fair or not is a value judgment. In making it, however, one should keep in mind the fact that these people already bear the lion's share of social security contributions as well as the regressive "hidden taxes," of subsidization and protectionism that raise Japan's food, shelter and other costs to among the highest in the world. It may very well be that their taxes should increase as the nature and scale of the Japanese fiscal regime change through ageing, globalization, and other pressures. But this conclusion should follow an honest appraisal of the options rather than a selective focus on the Anglo-American example and silence concerning such alternatives as progressive social security taxation.9 Sad to say, the well-organized opposition standing in the way of reinforcing equity in Japanese taxes suggests that this is not likely to happen.
Note also that social security contributions are both regressive and the most rapidly growing element of the Japanese tax system. On this, see Haruo Taniyama, Monogatari Zeisei Kaikaku (The Story of Tax Reform). Tokyo: Shin Nihon Shuppankai, 1998, pp. 135-6.
See "Genzei (Nado Fukkyou Kanwa Seisaku) to Nihon Keizai Saisei no Teeza" [Tax Cuts (and other anti-recession measures) and Theses on Japanese Economic Recovery], Zeiken, January 1999, p. 18.
On revenues, see OECD, Revenue Statistics, 1965-97. Information concerning top rates and the income levels they apply to can be found in Flip de Kam and Chiara Bronchi, "The income taxes people really pay," OECD Observer, March 1999 p. 13.
"Economic Anorexia: Japan's Real Demand Problem," Challenge, March/April 1999.
The Japanese Tax System, 2nd Ed. Oxford: Oxford University Press, 1993, pp. 172.
Some colorful comments on the budget can be found in "Genzei (Nado Fukkyou Kanwa Seisaku) to Nihon Keizai Saisei no Teeza" [Tax Cuts (and other anti-recession measures) and Theses on Japanese Economic Recovery], Zeiken, January 1999.
See, for example, Miyazawa's comments in David Hamilton's article, "Push to Trim Japan's Taxes Moves Steadily, if Slowly: Permanently Cutting Levies Could Swell the Deficit, Create Lasting Gains," Wall Street Journal, April 15, 1998, pp. A 17.
Some of these alternatives, including progressive social security taxation, are described in Masaru Kaneko's keynote speech to the 1999 meeting of the Japan Public Finance Association; see Zaiseigaku Kenkyu No. 24, May 1999, pp. 12-23.
ANDREW DEWIT is Associate Professor of Economic Policymaking at Shimonoseki City University and author of "Gendai zaisei shakaigaku no shochouryuu" (The Main Currents in Contemporary Fiscal Sociology), in Oshima Michiyoshi, et al (eds.), Nihon ga chokumen-suru zaisei mondai (Fiscal Problems Confronting Japan) (Tokyo: Yachiyo, 1999), pp. 249-75. During the year 1999-2000 he is the recipient of an Abe Fellowship to study tax politics in Japan and the Anglo-American countries.
Table 3 Revenue from Various Taxes in 1996 as Percent of Total Taxation
Income & Profits
Goods & Services
Source: OECD, Revenue Statistics, 1965-97
Table 4 Revenue from Various Taxes in 1996 as Percent of GDP
Income & Profits
Goods & Services
Source: OECD, Revenue Statistics, 1965-97
Table 8 Comparative Personal Income Tax Burdens, 1999* (Units: ten thousand yen)
*Tax payments are calculated for a salaried worker with a spouse and two children. Source: Ministry of Finance, Japan